What is IR35? A quick guide for contractors
If you are contracting, you would have heard of IR35 (the “Intermediaries Legislation”) or Off-Payroll as it is now commonly referred to. If you are new to contracting and haven’t heard of IR35 before, it is a piece of legislation – introduced in 2000 and adjusted over the years – that determines how contractors pay taxes.
IR35 is aimed at contractors who operate through intermediaries, i.e. Personal Service Companies (PSCs) otherwise known as limited companies.
It’s important that you familiarise yourself with IR35 to avoid potential HMRC tax investigations and penalties for not abiding by the legislation.
What is IR35?
IR35 was created with anti-tax avoidance in mind. As contractors and freelancers working through PSCs are able to pay themselves through a combination of salary and dividends, HMRC had to come up with a way of making sure that contractors who were similar to permanent employees paid the right amount of tax.
The way this is done is by a test which determines whether a contractor’s assignment falls ‘inside IR35’ or ‘outside IR35’. These are defined as follows:
Inside IR35: you are a ‘disguised employee’ and you are operating within the legislation. Effectively this means you work as a contractor but the actual work you do is similar to a regular employee, meaning you should pay similar taxes. Anyone who works inside IR35 must have their earnings taxed at source – whether that’s via agency PAYE or by an umbrella company. It is not financially beneficial for a contractor to operate inside IR35 through their own limited company.
Outside IR35: when your contract role is outside IR35, you are operating outside the scope of the legislation and are considered to be ‘genuinely self-employed’. When you are outside IR35, your contract and working circumstances will show that your work is different enough from a regular employee that you are able to maximise your take home pay like a true self-employed person.
How do I know if I am inside or outside IR35?
If you work in the private sector through your own limited company, your end-client will be responsible for deciding your IR35 status from 6th April 2020. It’s always a good idea to get a second opinion from a tax status specialist, but in the end it is your end-client’s responsibility to make the determination. All payments made – not work completed – from 6th April will need to have the new rules applied, so you should clarify as soon as possible whether your contract will or will not fall within IR35.
The latest off-payroll rules are already in effect in the public sector. These were changed in 2017 to ensure that all public sector clients took the responsibility of determining a contractor’s IR35 status on a case-by-case basis.
Most public sector contracts fall inside IR35, therefore if you are taking on a public sector contract role there is a good chance you will be caught by IR35. If this is the case, it is more worthwhile to either work through an umbrella company or look at other options such as negotiate a higher rate from your client. If you are taking on a private sector contract, it may be worthwhile keeping your limited company open until the market settles and you have an opportunity to seek outside IR35 contracts.
How is my IR35 status determined?
Three key factors that help determine your IR35 status are control, substitution and mutuality of obligation. We explain:
- Control: how much control does your end-client have over how, when and where you complete the work set out in your contract?
- Substitution: can you, or must you, send someone else to complete your work in your place if you are unable to?
- Mutuality of obligation: is your client obligated to give you work and pay you for it and are you obligated to accept?
As well as these three pillars, your end-client will also need to determine the following of your role: ‘financial risk’, ‘freedom to offer services to others’, and ‘part and parcel of the organisation’. These tests help indicate whether or not the work you do is similar enough to regular employees to place you within the legislation.